The current Supreme Court has been described as friendly to corporate interests. Its nine member justices recently defied that broad-brush characterization when they unanimously sided with investors suing the maker of Zicam Cold Remedy for not reporting side effects of the therapy to them. The decision is likely to complicate life for biotechs and other businesses.

The High Court didn’t offer much guidance to Zicam maker Matrixx Initiatives and others looking for clarity about when they need to disclose adverse events to investors and the rest of the public or when they can hold off on a disclosure without risking a securities lawsuit. Justices rejected Matrixx’ request for a hard-and-fast standard or “bright-line rule” defining when drug adverse-event reports are material and require disclosure.

Instead, in Matrixx Initiatives Inc. et. al. v. Siracusano et. al., the justices ruled that investor James Siracusano and a class of investor plaintiffs can pursue a class-action lawsuit against the Zicam maker, acquired by HIG Capital in February. The Supreme Court upheld the US Court of Appeals for the Ninth Circuit’s unanimous 2009 ruling for Siracusano, which overturned a decision favoring Matrixx that was rendered three years earlier by the US District Court for the District of Arizona.

The lower court had agreed with Matrixx that materiality should be limited to disclosures that revealed a statistically significant risk of adverse events occurring due to Zicam’s use. This standard was developed by the appeals court’s Second Circuit in deciding In re Carter-Wallace, Inc. Sec. Litig. Carter-Wallace, which required disclosure if adverse reports are sufficiently serious and frequent and would affect future earnings. It also required disclosure even if there is no statistically significant link but the company concludes that the safety is serious enough that the drug will not likely be approved or marketed.

The Ninth Circuit ruled that deliberate knowledge, or scienter, to deceive, manipulate, or defraud could be established by a showing of “deliberate recklessness.” The Supreme Court didn’t rule on the issue, since Matrixx did not challenge the appeals court on that point.

Cogent and Compelling Inference

At issue was Siracusano’s claim that Matrixx defrauded investors when it failed to disclose what it knew about Zicam users developing loss of smell, or anosmia, since the drug entered the market in 1999. Justice Sonia Sotomayor said the investors could argue that Matrixx materially misled investors by not disclosing years of reports of a possible link between Zicam and anosmia even if the reports did not show a statistically significant number of adverse reports.

Zicam’s association with anosmia began with a doctor’s report to the company that year of a patient who complained of anosmia. Additional reports of anosmia linked to the cold remedy emerged, followed by lawsuits. News reports led to drops in stock price, which in turn led Siracusano and investors to file suit.

Yet Matrixx maintained optimistic forecasts of further growth for Zicam in press releases, SEC filings, and conference calls with analysts. That may help explain why the company’s 2004 net income of about $4.96 million surpassed 2003’s $3.34 million, while net sales went from almost $43.5 million in ’03 to $60.23 million in ’04.

“The complaint’s allegations, taken collectively, give rise to a cogent and compelling inference that Matrixx elected not to disclose adverse event reports not because it believed they were meaningless but because it understood their likely effect on the market,” Sotomayor wrote in the court’s decision. “The inference that Matrixx acted recklessly (or intentionally, for that matter) is at least as compelling, if not more compelling, than the inference that it simply thought the reports did not indicate anything meaningful about adverse reactions.”

Among Matrixx’ supporters in the case was BayBio, the life science industry group for the San Francisco Bay Area and northern California. BayBio filed an amicus curiae brief with the Supreme Court contending that a decision for Siracusano would enable many more investors to win jury trials for their drug safety claims based on adverse events, no matter their significance.

“If the Ninth Circuit’s decision is left standing, a securities plaintiff will be able to survive the pleadings stage and potentially get to the jury on claims based on drug safety simply by alleging the failure to disclose a meaningless adverse event—an allegation a plaintiff almost certainly will be able to make,” BayBio argued.

Sotomayor appeared to acknowledge that possibility when she wrote that the Court stood by Basic Inc. v. Levinson, which holds that the standard for a material omission is satisfied when there is “a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.” Under that standard, Sotomayor noted that pharma manufacturers do not have to disclose all reports of adverse events.

Potential for More Securities Lawsuits

Stephen B. Thau, a partner with the law firm Morrison & Foerster and co-chair of its Life Sciences Group, and a lawyer representing BayBio in the Matrixx case, told GEN the Supreme Court’s decision upheld existing law on the topic and did not go beyond the immediate case. Thau said companies will need to carefully decide what to disclose based on the specific facts of a given situation, including cautionary language and balanced disclosure.

“Companies sometimes find it frustrating, and I think frankly investors find it a little bit frustrating and confusing, because it leads to a little less filtering sometimes than would be helpful,” Thau said.

That will prove especially challenging, he said, for small companies. “They want to be out in front of the investment community talking about their products. And at the same time, they need to make sure that what they are saying is complete and accurate, and that in hindsight, they won’t get accused of having cherry-picked only the good information and not disclosed the bad information.

“It’s a very challenging dance that companies have to make. You can always be second-guessed in hindsight, and you want to present an accurate and balanced picture of the information.”

Asked if the decision may dissuade smaller companies from going public, Thau noted that disclosure was just one of several challenges they face. “This was an opportunity to make going public more inviting, and the Supreme Court did not move in that direction.”

Instead, the Court paved the way for a new wave of securities lawsuits, as investors who lose money will be more easily able to attribute their losses to information companies failed to disclose, Richard Samp, chief counsel, Litigation Division with the Washington Legal Foundation, told GEN.

“It will be very difficult for any defendant in one of these kinds of cases to win dismissal for the case at the pleading stage,” Samp said. “If a company cannot win dismissal at that stage, very often it is essentially required to settle the case because it’s just too expensive and too risky a proposition to take it all the way to trial. You’ll probably see many more of these kinds of cases.”

Most plaintiffs attorneys, Samp said, will now recognize that they can avoid motions to dismiss their suits. “Therefore, they should be able to enter into a reasonably lucrative settlement.” That will add to companies’ costs through higher insurance premiums, he predicted.

“There probably will be more disclosure as a result of this decision. But I don’t think that increased disclosure will succeed in reducing the number of lawsuits,” Samp said. “No matter how much disclosure they do, the plaintiffs’ lawyers are going to argue that companies should have done more.”

Joseph C. Weinstein, a partner with the law firm Squire Sanders & Dempsey and chair of its securities and shareholder litigation practice, said life sciences companies will have to proceed more cautiously when it comes to decisions whether or not to disclose adverse events.

“I think the decision is going to change the way a lot of pharma companies do business,” Weinstein said. “Until now, there may have been what we now know was over-reliance on not reporting things that weren’t statistically significant. Now there’s got to be more assessment about the information a company has, particularly when it’s making public statements about its business or about the products that may be at issue.”

As the Supreme Court noted, the FDA does not limit the criteria for its decisions to statistically significant data. That led the Court to ask, why should investors?

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